Commentary

How nations are repeating mistakes of the 1930s

Commentary: Globalization is in decline, and the world is poorer for it

By

SatyajitDas

SYDNEY (MarketWatch) — Evidence of the end of globalization is mounting. Growth in trade and cross border investment, which has underpinned prosperity and development, is being reversed in a major historical shift.

As English politician Lord Palmerston noted: “Nations have no permanent friends or allies, they only have permanent interests.”

In the aftermath of the global financial crisis, these interests dictate a return to autarky — a closed economy with limited international trade or capital flows.

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The post-Second World War period saw remarkable expansion in global trade and capital flows. In a virtuous cycle, globalization both created and relied on strong economic growth. Individual nations sacrificed national interest as the benefits of integration outweighed costs.

Enlightened self-interest underpinned the system, as long as it delivered prosperity for most nations. For many nations, following the global financial crisis, the advantages of greater economic and monetary integration are now less obvious.

Inward focus

Economic growth overall has slowed and is likely to be tepid for an extended period. By closing their economies and focusing domestically, some nations believe that they can capture a greater share of available growth and deliver greater prosperity for their citizens.

For emerging nations, the benefits of participation in the global economic system, which previously assisted improvements in their living standards, are now diminished. They are wary of having to pay for the problems of many developed countries.

In an economically integrated world, supply chains for goods and vital commodities are international rather than national. This makes them sensitive to changes in cost structures, currency values and transportation costs as well as vulnerable to disruption from climatic or environmental factors. Increased recognition that specialization leaves national and regional economies vulnerable to competitive pressure from other nations or localities or dislocations in supply chains may also drive a reversal of globalization and a shift to more closed economies.

The financial crisis revealed that integration reduces the effectiveness of a nation’s economic policies, unless other nations take coordinated action.

Governments reacted to the global financial crisis by initiating large spending programs to support the economy. In many cases, there was significant financial leakage, with spending boosting imports rather than promoting domestic demand, employment, income and investment. Changes in tax policy can be rendered ineffective if other countries do not follow suit.

Various breakdowns — restrictions on trade, currency manipulation, capital controls and predatory regulations — now signal the retrenchment of globalization and return to autarky.

Restictive policies

Despite oft-repeated statements at G-20 meetings about the importance of free trade and avoiding the mistakes of the 1930s, trade restrictions are increasing. The motivation is protection of national industries, iconic businesses, employment, incomes and competitive advantage.

Subsidies, government procurement policies favoring national suppliers, “buy local” campaigns, preferential financing and industry assistance policies are used to direct demand. Safety and environmental standards are used to prevent foreign products penetrating national markets.

Free movement of capital has become increasingly restricted. Since 2008, the growth in cross border capital flows has slowed, with global financial assets increasing by just 1.9% annually — well below the 7.9% average growth from 1990 to 2007.

In addition, nations with high levels of government debt that face financing difficulties seek to limit capital outflows.

Low interest rates and weak currencies in developed economies have led capital to flow into emerging nations, with higher rates and stronger growth prospects. Volatile, short term capital inflows threaten to destabilize economies, by driving up the value of currencies and creating inflationary pressures. Brazil, South Korea and Switzerland have implemented controls on capital inflows.

Meanwhile, nations are increasingly using regulatory initiatives to gain advantage.

In the aftermath of the financial crisis, developed nations worked together to strengthen regulation of financial institutions. The proposals were intended to be adopted internationally, ensuring consistency and a level playing field.

Stringent regulations of multinational financial institutions, active in complex financial products, may not be appropriate for countries with less-developed financial systems. Under the guise of regulations needed to strengthen the financial system, the U.S. has implemented measures whose extra-territorial application may give American banks a business advantage.

Emerging nations especially argue that adoption of these proposals would impede the ability of local banks to provide credit necessary to support local economies. It would also pose significant compliance costs and erode their competitive position. They are increasingly skeptical about accepting such regulatory standards.

These differences may lead to the lack of uniform financial regulation, resulting in a Balkanized global financial system.

All of these steps impede free movement of capital, one of the hallmarks of globalization.

Autarky or closed economies is a natural way to deal with these pressures, reasserting sovereign control. As one nation adopts such policies, it compels other countries to pursue similar strategies.

Despite the economic benefits of global trade, a retreat to autarky and pursuance of policies that favor closed economies is now a serious possibility — with far-reaching consequences.

Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money

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